Baby Step 6 of Dave Ramsey’s Plan is to pay off your home mortgage early and be completely DEBT FREE. 

Similar to Baby Step 2, where you pay off all of your debts except for your home, you should use focused intensity and throw a good portion of your discretionary income (above your 15% retirement contribution and kid’s college funds) toward extra principal payments on your mortgage and knock it out as quickly as possible.  The more intense you become and the more that you are willing to sacrifice, the faster you will pay off your home.  As Dave says, when you own your home free and clear, if you take off your shoes and walk through the back yard, the grass will feel different under your feet.

There are some so-called experts out there who will tell you that it is not wise to pay off your home early.  They usually use one of two arguments to back their false cliams:

Argument #1:  Because mortgage rates are at an all-time low right now (4-5%), they say that you should keep your mortgage and invest your discretionary income in things that could earn you a higher rate of return like mutual funds and stocks.

Rebuttal #1:  They may be correct in their assertion that your could earn a higher rate of return in mutual funds and stocks, but they forgot to factor two things into their equation:  Risk and Taxes.

Risk comes when you still have a mortgage and your company downsizes.  Think about it…  If your company lays you off tomorrow and you have a paid-for house and no payments of any kind in the world, your stress levels would be completely different from someone who would immediately be worried about losing the home where their family sleeps at night.

Also, you will owe capital gains taxes if you invest in mutual funds or stocks and make a profit.  Capital gains taxes are around 15% for most people.

After factoring risk and taxes into the equation, your rate of return on that investment will come closer to the 4-5% that you would earn by not having a mortgage. 

Finally, if you are still not convinced that paying off your mortgage is a good idea, then ask yourself this question:  If you had a completely paid-for home, would you borrow money against it to invest in a mutual fund or the stock market?  If the answer to this question is “No”, then you should pay off your mortgage as quickly as possible and never look back!

Argument #2:  It is not wise to pay off your mortgage early because you will lose the tax deduction.

Rebuttal #2:  I have written a complete article about this argument.  Basically, with a tax deduction, for every dollar that you pay in interest to the bank, you save 25 cents on your taxes (this may be higher or lower depending upon your tax bracket) in the form of a tax deduction.  Trading whole dollars for quarters is unwise.  If you really want a tax deduction, then give the amount that you would be paying in interest to your local church or qualifying charity and you will earn the exact same tax deduction without having to stay in debt to do so.

My wife and I are set to start Baby Step 6 this year.  We are very excited about owning our home free and clear.  We can’t wait to walk through the back yard and see how different the grass will feel under our feet when it belongs to us and not the bank!

As followers of Dave Ramsey’s plan, the only mortgage that we would ever take out is a 15 year fixed rate mortgage where the payment is no more than 25% of our monthly household take home pay.

Using those guidelines, let’s say that we wanted to purchase a $150,000 home and the interest rate is 5%.  The numbers would be:

Monthly Payment:  $1,186.19
Total Interest Paid:  $63,519.19

Suppose, however, that instead of a 15 year mortgage, we decided to reduce our  monthly payment and take out a 30 year mortgage instead.  The numbers would be:

Monthly Payment:  $805.23
Total Interest Paid:  $139,888.62

In summary, by taking out a 15 year mortgage instead of a 30 year mortgage, we would pay $380.96 more per month, but we would save $76,369.43 in interest, not to mention that we would be out of debt 15 years earlier!

Never take out more than a 15 year mortgage under any circumstance!  If you cannot afford the payment on a 15 year mortgage, then you are trying to buy too much house for your income level.

Some Financial Advisers recommend that their clients not pay off their mortgage early because the mortgage interest creates a tax deduction.  This is bad advice and the example below that Dave Ramsey uses illustrates why:

Let’s suppose that you have a $200,000 mortgage with a 5% interest rate.
This means that you would pay roughly $10,000 in interest this year ($200,000 x .05).

Now, lets suppose that your income is $50,000 per year and that put you in a 25% tax bracket. 

With the mortgage above, you would be able to take a tax deduction of $10,000, so instead of paying taxes on $50,000, you would pay taxes on $40,000. 

In a 25% tax bracket, taxes on $10,000 would be $2,500 ($10,000 x .25).  So, having a mortgage saved you $2,500 on taxes.  That’s good news, right?  Not really.  In order to save that $2,500 in taxes, you paid $10,000 in interest to the bank that holds your mortgage. 

You swapped $10,000 for $2,500.  That is a bad idea!

If you really want the $2,500 tax deduction, then give $10,000 to your church or a qualified charity.  The tax deduction is exactly the same as if you had a mortgage, but you did not have to stay in debt and risk your home in order to get it!

Personally, I would stay away from any Financial Adviser who recommends that I keep a mortgage for the tax deduction.